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NZ Super calls for tax-free status, new chief expected this month

June 3, 2018

Matt Whineray: NZ Super Fund CIO

The NZ Superannuation Fund (NZS) has lobbied for exempt status in a submission to the Sir Michael Cullen-led Tax Working Group (TWG).

In a just-published submission the NZS, which has paid $6.25 billion in tax since inception in 2003, argues shifting to the globally standard tax-free model for sovereign wealth funds (SWFs) would be a more efficient and equitable way to manage its obligations.

“Ideally the Fund should be tax exempt in line with best practice tax treatment for SWFs around the world (we are the only SWF that is not exempt from tax in its home jurisdiction),” the NZS paper says.

By contrast, the similarly-sized Accident Compensation Commission (ACC) does not pay tax. While former NZS boss, Adrian Orr, previously put the case for tax-exemption (incurring a slap-down from then Finance Minister, Bill English), the TWG submission lays out several local and global advantages for bypassing the Inland Revenue Department (IRD), including:

lowering government contributions over time in line with the mandated ‘funding formula’;

NZS would no longer need to sell-down assets to pay tax or indulge in complex tax management procedures; and,

the fund could more easily argue for the standard SWF tax exemptions granted in offshore jurisdictions if it is not taxed at home.

Barring its preferred exempt option, the NZS paper offers a number of suggestions to streamline its affairs including a pro-rata trade-off between tax due and government contributions.

“It would reduce transaction costs for both the Fund (in respect of being required to realise investments) and the Government if the Fund was able to offset the Fund’s provisional tax due to the Government against the Government contributions to the Fund,” the submission says. “We have discussed this concept with the Treasury previously and would welcome the Working Group’s support for this measure.”

The NZS paper – signed off by acting chief, Matt Whineray, and head of tax, John Payne – points out that, principally due to the vagaries of fair dividend rate (FDR) regime for global equities, the fund’s effective annual tax rate tends to fluctuate wildly.

“For example, our effective tax rate was 3% in 2015, 96% in 2016 and 20% in 2017. The main driver of this volatility is how our physical global equities are taxed under the FDR regime,” the submission says. “In simple terms, this means that in any given year if our return on global equities exceeds 5%, then our tax rate will be lower than 28%, and if our returns are less than 5% then our tax rate will be higher than 28%.”

The NZS currently invests almost two-thirds of its $38.5 billion in offshore shares.

Other measures mooted in the NZS submission include: extending the new pay-as-you-go provisional tax Accounting Income Method – currently restricted to businesses with under $5 million annual revenue – to all entities; and, allowing “real time” engagement with IRD around the “exceedingly complex” global tax rules for foreign investment funds (FIFs) and controlled foreign companies (CFCs).

More broadly, the NZS supports lowering the deemed FDR impost – which levies an annual tax based on 5 per cent of the value of underlying assets – to 3 per cent, as per the TWG background paper proposal.

“We agree with the Working Group’s proposition that the current FDR rate of 5% is too high,” the NZS submission says. “We would recommend a review of the level of the rate with the view to reducing it.”

And in another move that would have implications across the investment industry, the NZS also pushes for clarity on how FDR intersects with the currency hedging rules.

The NZS has been in “ongoing discussion” with IRD and Treasury regarding the complex treatment of foreign exchange hedging under FDR, the submission says.

“These rules were intended to align the taxation of FDR and Australasian equity investments subject to the PIE exemption (which are subject to tax on a 5% deemed dividend or actual dividends received respectively) with the hedging of these investments (with gains being fully taxable and losses fully deductible),” the NZS paper says. “These rules are a good example of a regime that was supported by industry but has been poorly implemented via overly prescriptive rules.”

Despite the above niggles, the NZS says the existing investment tax regime – including FDR and the portfolio investment entity (PIE) rules – “work[s] well and should remain”.

“There should be a ‘high hurdle’ before seeking to make any changes to industry specific tax regimes,” the submission says. “Any adverse tax changes would have a direct effect on future investments and current asset values.”

This month the NZS is expected to name its new leader to replace Orr, who left to head the country’s central bank in March.

A NZS spokesperson said the fund was “on track” to appoint Orr’s successor in June. It is understood a number of candidates were in the frame including acting chief, Whineray.

The recruitment process has been hampered, too, by new proposed legislation that would limit the remuneration of top-level public servants, including the NZS CEO.

In part inspired by the $1 million plus remuneration package of former chief, Orr, the State Sector and Crown Entities Reform Bill would give more power to central government to rein-in public servant executive salaries.

Catherine Savage, NZS Board of Guardians chair, argued against capturing the fund under the legislation, calling instead for it to be treated as an ‘arms-length’ state-owned enterprise.

Savage said in a submission last month to the Governance and Administration Select Committee considering the bill: “We are also mindful of the costs and risk of underperformance of the Fund should we not recruit or retain a Chief Executive with the right attitude, skills and experience.

“Ultimately the Board is accountable for and will be measured on whether or not the Guardians meets its long-term outcomes, as set out in the Statement of Intent. Removing from the Guardians Board the fundamental Board responsibility of appointing and remunerating the Chief Executive undermines that accountability.”

If the NZS is caught in the proposed act, Savage said it should include “some amendments to mitigate the risks of undermining the operational independence and accountability of the Board of the Guardians”.